The Real Effects of Monetary Expansions: Evidence from a Large-scale Historical Experiment

Abstract

The discovery of massive deposits of precious metals in America during the early modern period caused an exogenous monetary injection to Europe's money supply. I use this episode to identify the causal effects of money. Using a panel of six European countries, I find that monetary expansions had a material impact on real economic activity. The magnitudes are substantial and persist for a long time: an exogenous 10% increase in the production of precious metals in America measured relative to the European stock leads to a front-loaded response of output and, to a lesser extent, inflation. There was a positive hump-shaped response of real GDP, with a cumulative increase up to 0.9% six to nine years later. The evidence suggests that this is because prices responded to monetary injections with considerable lags.

Spending a Windfall

“…We use data on the production of gold and silver in the mines in America from Palma (2022), who largely relies on TePaske (2010) and covers the period until 1790. Here, we use the same sources and procedures from Palma (2022) to extend the data to 1810.…”

“…We use data on the production of gold and silver in the mines in America from Palma (2022), who largely relies on TePaske (2010) and covers the period until 1790. Here, we use the same sources and procedures from Palma (2022) to extend the data to 1810. That year marks the end of TePaske's data set as well as the beginning of the Spanish American wars of independence that greatly disrupted silver production and transportation to Europe.…”

“…DISCOVERIES OF PRECIOUS METALS PER CAPITA Source: Palma (2022) 1531–1790; and the same sources used by Palma (2022) for the remaining years.…”

“…For each time horizon h , we estimate the following equation: $$$$\begin{equation} \ln y_{t+h} - \ln y_{t-1} = \beta _h \operatorname{metals}_{t} + \mathbf {{\Psi }_{h}} \mathbf {x_{t}} + u_{t+h}, \end{equation}$$$$where $$ y_{t}$$ denotes shipping capacity on period t and the left‐hand side of Equation () denotes the cumulative growth of shipping capacity from period $$ t-1$$ to $$ t+h$$. The independent variable $$ \operatorname{metals}_{t}$$ is the production of precious metals in America relative to the stock of metals in Europe, taken from Palma (2022). The vector $$ \mathbf {x_{t}}$$ contains a linear trend and four lags of the dependent variable $$ \ln y_{t}$$.…”

Output Divergence in Fixed Exchange Rate Regimes: Is the Euro Area Growing Apart?

“…Also in a closed economy NK model with endogenous growth, Moran and Queralto (2018) show that monetary policy can induce medium-run movements in productivity. Recent empirical evidence in support of long-run money non-neutrality comes from Jordà et al (2020) and Palma (2021) who make use of historical time series that span more than a century to trace the long-run e↵ects of monetary shocks. We extend this empirical evidence to the open-economy setting by documenting that TFP growth declines upon fixing the exchange rate for countries with a high structural wage inflation rate.…”